Brazil’s Enormous Interest Rate Tax: Can Brazilians Afford It?

[Pages:18]CEPR

CENTER FOR ECONOMIC AND POLICY RESEARCH

Brazil's Enormous Interest Rate Tax: Can Brazilians Afford It?

By Mark Weisbrot, Jake Johnston, Julia Villarruel Carrillo, and Vitor Mello* Updated April 2017

Center for Economic and Policy Research 1611 Connecticut Ave. NW Suite 400 Washington, DC 20009

tel: 202-293-5380 fax: 202-588-1356

Mark Weisbrot is the Co-Director and an Economist at the Center for Economic and Policy Research (CEPR) in Washington, DC. Jake Johnston is a Research Associate, Julia Villarruel Carrillo is a former International Program Intern, and Vitor Mello is an International Program Intern at CEPR.

Contents

Executive Summary...........................................................................................................................................2 Brazil's Enormous Interest Rate Tax: Can Brazilians Afford It? ...............................................................4 Conclusion ........................................................................................................................................................12 References .........................................................................................................................................................15

Acknowledgements

The authors thank Dan Beeton, Alexander Main, and Rebecca Watts for helpful comments and editorial assistance. They thank Franklin Serrano and Ricardo Summa for helpful comments.

Executive Summary

Brazil is currently paying a very high price, in terms of its economic growth, employment, development, and social progress due to its exorbitantly high interest rates. Interest payments on the public debt for 2016 are estimated at 7.6 percent of GDP. This is the fourth-highest interest burden in the world (out of a total of 183 countries). Other countries with a similar burden, such as Yemen and Egypt, are plagued by civil conflict and other risk factors that would be expected to increase the probability of default. Brazil, by contrast, has little risk of default, and with 360 billion USD in international reserves, there is not much likelihood of balance of payments crises that could lead to runaway inflation.

The largest component of government debt consists of bonds tied to the Selic rate, which is the overnight lending rate set by the Central Bank. These bonds make up 46.3 percent of government debt. Since January of 2003, the nominal Selic rate has averaged 13.25 percent and the real rate (adjusted for inflation) has averaged 6.14 percent. This is an extremely high real interest rate over this period, which also appears to be unexplainable by known risk factors.

For 2003?2015, Brazil's real policy interest rate (the Selic rate) was the fifth-highest in the world (out of 68 countries that have five years of data). Again, the few countries with higher interest rates, such as the Democratic Republic of Congo or Tajikistan, are not in the same category as Brazil for the various factors expected to affect interest rates.

The evidence presented in this paper indicates that Brazil's exorbitantly high interest rates are a policy choice, rather than a result of structural factors such as chronically low savings rates. The high interest rates are part of a policy of inflation targeting that has often worked by using interest rates to raise the value of Brazil's currency (the real), thereby lowering the prices of tradable goods. This policy has often been procyclical, thus adding to the damage to employment and growth during downturns.

Brazil's largest banks may use both their market power and political power to support Brazil's high interest rate regime. Their share of assets has increased from 53 percent in 2003 to over 72 percent today. Between mid-2012 and January 2017, the spread between the banks' average (commercial and consumer) lending rate and their cost of funds increased from 12.8 to 23.8 percent. This was at a time when the economy was slowing and then went into deepening recession, which has become Brazil's worst downturn in more than three decades.

Brazil's Enormous Interest Rate Tax: Can Brazilians Afford It?

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It appears that banks were able to make up for the decline in credit growth not only by the higher and risk-free yield from government bonds, but by increasing the spread between their lending and borrowing rates. This could be due to the relative lack of competition in the financial sector.

The safe guaranteed return from government bonds -- not only the high Selic rate, but other bonds that offer protection against inflation or changes in the exchange rate -- are an enormous source of profitability for Brazil's financial sector. For the years 2003?2015, the profits of the four biggest banks rose by 460 percent -- from 5 billion reais to more than 28 billion reais.

In the immediate present, one of the most damaging aspects of Brazil's high interest rates is the weight of interest payments in the national budget, in the context of the highly dysfunctional national debate over Brazil's central government budget deficit. The increase in the interest burden of the debt since 2012 accounts for about half of the increase in the central government budget deficit, which has risen from 2.5 percent of GDP to a projected 10.4 percent of GDP for 2016.

Lower interest rates could open up fiscal space for a sizable stimulus that could help bring about an economic recovery. However, the government has gone in the opposite direction, achieving the passage of a constitutional amendment to hold real (inflation-adjusted) federal spending constant for the next 20 years.

As can be seen in Figure 4, Brazil had very little GDP per person growth for the entire 23-year period of 1980?2003, less than 0.2 percent annually. From 2003 to 2011, per capita GDP growth rebounded sharply for an annual average of 3.3 percent. But growth began to slow in 2011; for 2011?2016, per capita GDP fell 1.3 percent annually. Brazil is now more than halfway to reproducing -- or, at this rate, doing much worse than -- the lost decade of the 1980s.

Like the unprecedented long-term growth collapse of 1980?2003, the current slump is the result of macroeconomic policy errors. Brazil's unique interest rate policies are a major part of the policy mistakes that, if not subject to serious and long-term change, could condemn the country to another very long period of profound economic failure.

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Brazil's Enormous Interest Rate Tax: Can Brazilians Afford It?

For many years, Brazil has ranked at or near the top of all countries in terms of both its real interest rates and the interest burden on its public debt. Table 1 shows the top seven countries in the world in terms of the percentage of GDP they are estimated to pay on their public debt in 2016. Chronically high real interest rates can have many costs, including the slowing of investment, economic growth, and development, and all of the attendant effects of reduced employment and upward redistribution of income and wealth. The annual interest payments on the public debt do not encapsulate these broader impacts, but they are one important measure of the immediate burden of high interest rates. They are also particularly important in a time when there is political pressure to reduce government spending, as is the case currently in Brazil. Brazil ranks fourth of 183 countries for which data is available, allocating 7.63 percent of GDP for interest payments on the debt.

TABLE 1

Comparison of Countries with Highest Interest Burdens

Country Lebanon

Interest Burden (% of GDP)

Gross Debt (% of GDP)

9.15

143.87

Net Debt (% of GDP)

137.67

International Reserves

(in months of imports)

Current Account Balance

(% of GDP)

32.23

-16.03

Gambia Yemen

8.81

99.44

99.44

8.36

82.38

81.31

1.54

N/A

5.12

-8.02

Brazil

7.63

78.28

45.83

22.68

-3.32

Egypt Jamaica

7.63

94.63

7.60

118.85

86.17 N/A

2.73

-1.98

6.51

-0.14

Ghana

6.36

65.97

64.18

3.79

-1.90

Source and notes: Interest Burden data, authors' calculations, IMF (2016d). Gross and Net Debt data from IMF

(2016d). Current Account Balance data, authors' calculations based on data from IMF (2016a) and IMF (2016d) (data

for 2015, except Egypt 2014). International reserves data, authors' calculations based on data from World Bank (2016) and IMF (2016b). For International Reserves, all data is from 2015, except for Gambia.

A large interest burden from the public debt, as a percent of GDP, is a result of some combination of a large debt (relative to GDP) and high interest rates on the outstanding debt. For example, Lebanon ranks first in Table 1, paying more than 9 percent of GDP annually on its public debt. But it has a much larger public debt than Brazil; with a gross debt of 144 percent of GDP, the implied nominal interest rate on its debt is about 6 percent, as opposed to about 10 percent for Brazil. Also, Lebanon is running an enormous current account deficit of 16 percent of GDP, which carries some risk of a balance of payments crisis. In such circumstances, we would expect higher interest rates in order to keep capital in the country. Balance of payments crises can also lead to very high inflation, which poses risks to bondholders.

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The other countries with interest burdens comparable to Brazil also have serious problems that could be expected to increase the risk of default and/or to raise the interest rate on their debt. Yemen is currently engulfed in a brutal civil war and has suffered from considerable political instability for many years. Egypt, with an interest burden the same as Brazil's, has also been politically unstable, especially in the past six years; and as recently as 2009, before the political unrest heated up, its interest burden was just 3 percent of GDP. Jamaica has long suffered from an unsustainable debt burden even after two debt restructurings, the last one in 2013.1 It has had negative per capita GDP growth over the past 20 years, partly because of the burden of its unsustainable debt.2 Jamaica is currently operating under an IMF agreement, which, like previous agreements, commits the government to a monetary policy that is acceptable to IMF authorities.

We can see that Brazil is not comparable to any of these countries with high debt burdens in terms of its circumstances and the risk of default. Although Brazil's congress impeached President Dilma Rousseff in August 2016, the whole process and result never contributed to any increased risk of default. In fact, the financial markets reacted with great enthusiasm to the impeachment process and its results, with the Brazilian currency rallying by 25 percent3 and the stock market climbing by over 40 percent in 2016 -- one of the best performances in an emerging market country over this time period for both the currency and the stock market.

Brazil's current account deficit was 3.3 percent of GDP for 2015. The government holds more than 360 billion USD in foreign exchange reserves, an amount equivalent to nearly two years of imports. This is a very large amount of international reserves; normally reserves that would pay for a few months of imports for a country like Brazil would be considered sufficient. Brazil does not appear to be vulnerable to serious balance of payments problems in the foreseeable future.

Brazil's gross debt is now estimated at 78.3 percent of GDP, with net debt at 46 percent. Brazil's high interest burden is the result of the high interest rates that it pays on its gross debt; this is much higher than the interest that it receives on its assets, e.g., the 360 billion USD in international reserves. These are mostly invested in relatively low-yielding, liquid assets such as US Treasury securities. We estimate the average interest rate on Brazil's general government gross debt to be about 10.3 percent in 2016.4

1 See Johnston (2013) and Johnston (2015). 2 See Serrano and Summa (2015) and Weisbrot, Johnston, and Lefebvre (2014). 3 Banco Central do Brasil (BCB) (2017d). 4 This is from interest payments in the 12 months until December 2016 divided by general government gross debt as of December

2015. See BCB (2017b), Quadro III and Quadro XIX. This is in line with IMF calculations and projections. See IMF (2015), p.7. For methodology, see: .

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In any case, the persistent high interest rates on Brazil's debt cannot be explained by a risk of default, inflation risks, or the risk of balance of payments crises. About 95 percent of Brazil's public debt is in domestic currency. Although inflation spiked in 2015 to 10 percent, it has since receded and more importantly was within its target range of 2.5?6.5 percent from 2004 through 2014.5

Table 2 shows the composition of this debt since 2006.

TABLE 2

Composition of Brazil Debt by Year

(percent of overall debt)

Exchange Rate

Index

Price Index

Selic Index

2006

11.85

20.20

35.55

2007

7.66

22.29

37.61

2008

8.52

22.49

43.35

2009

5.63

21.17

47.20

2010

5.34

23.16

39.14

2011

4.79

23.98

38.73

2012

4.91

26.55

35.97

2013

5.36

26.73

33.35

2014

5.82

24.65

37.72

2015

6.88

23.23

39.20

2016

5.52

22.76

43.82

2017

5.14

23.09

46.25

Source and notes: End of year data, except for 2017 (January). BCB (2017b).

Pre-Fixed 30.03 30.28 23.97 24.41 30.67 30.80 30.83 32.25 29.15 28.06 25.43 23.20

Other 2.37 2.17 1.67 1.59 1.69 1.70 1.73 2.30 2.66 2.63 2.47 2.32

The biggest component of the debt, at 46.3 percent, has interest rates determined by the Selic rate. This is the overnight rate, or policy rate, set by the Brazilian Central Bank.

Figure 1 shows the evolution of the Selic rate, both nominal and real, since January of 2003. The nominal rate has averaged 13.25 percent and the real rate 6.14 percent. This is an extremely high real interest rate over this period, which also appears unexplainable from any known risk factors. While the nominal Selic rate has recently been cut, it is important to note that the real Selic rate (adjusted for inflation) is actually higher than it has been at any time since December 2008.

5 See Weisbrot, Johnston, and Lefebvre (2014).

Brazil's Enormous Interest Rate Tax: Can Brazilians Afford It?

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FIGURE 1 Nominal and Real Selic Rate Over Time

30

25

Nominal Selic Rate Real Selic Rate

20

Percent

15

10

5

0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: BCB (2017c, e).

Table 3 shows the ten countries with the highest real policy interest rates in the world for the period 2003?2015. Brazil ranks fifth with 6.35 percent, behind the Democratic Republic of Congo.

TABLE 3

Highest Real Policy Interest Rates, 2003?2015

(percent)

Country

Real Policy Rate

Gambia, The Tajikistan

12.82 12.67

Belize Congo, Democratic Republic of

10.19 9.11

Brazil

6.35

Ghana

3.66

Kenya

3.49

Bahamas, The

3.08

Sao Tome and Principe

3.00

Senegal

2.51

Source and notes: Data for 68 countries that have at least the last five years of data available. IMF (2016c).

Francisco Lopes recently examined a number of possible theoretical explanations for Brazil's excessively high interest rates, including fiscal deficits, "inflation bias," excess demand for investment, and a structural deficiency in private savings.6 He finds that none of them seem likely.

6 Lopes (2014).

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